When it comes to investing, I love clear rules and simplicity. I'm fiercely logical and don't mind being different. I also have a good grasp on market history, I understand what goes up will come down, and I'm comfortable with losses because of my extremely high savings rate and long time line.
Being several years away from 30, my investment timeline is at least 60 years based on current life expectancy. I don't care what happens this year or five years from now because it's largely irrelevant in the big picture.
Buy-and-hold could work well for me, like it generally does for anyone with the discipline to stick with it. But, in my quest for being different and willingness to experiment with my own money, I've decided to invest my own portfolio in a very different strategy.
It's important to emphasize that this is not an endorsement of doing something other than buy-and-hold, nor a criticism of buy-and-hold. Pursuing something different means conviction of it's benefits, sound knowledge of the strategy, and strict adherence to the rules.
Investing is not a game where you dabble in and out of strategies as it suits. It's a commitment to your future well-being.
Macro-style Trend Investing
Macro: very large in scale, scope, or capability; of or relating to macroeconomics
Trend: the general course or prevailing tendency; drift
Macro-style trend investing is what it sounds like: purchasing investments which are large in scale and drifting upwards.
With this strategy I generally don't invest in individual stocks, I don't necessarily buy what is the cheapest, and I follow very specific, but broad rules to determine what I can purchase, when I can purchase, and when I must sell. I also pay special attention to tax triggers and trading costs.
Background & Criticisms of Trend Investing
Trend investing is actually a small corner of the retail investing world. When I mention it, people often look confused. It is wildly different from the more popular strategies out there: Boglehead indexing, Buffett-Graham value investing, the gold bugs, Lynch's investing in what you know, and the good old dividend crowd.
These other strategies are much easier to wrap your head around and are very talked about in the investing world. They are all based on popular paradigms and prove difficult to dispute because of herd mentality.
Pure trend on the other hand seems faddy and reckless. Using moving averages, ignoring current valuations, technical charting (gasp!). Some of the most popular jabs in the investing world include poking fun at "chartists".
But the fact is technical analysis has a long history and there are many very wealthy technical investors. I don't necessarily mean highly complex strategies, but basic trend combined with fastidious discipline. Jesse Livermore was a famous early-1900s trend investor who made, lost, made, and lost fortunes worth billions in today's money. Martin Zweig was a more recent example of proficient technical investing.
These men tended to be loners, working in small offices and being intensely private about their approaches to investing. For them, freedom from "noise" was an important element of their success. Successful technical investing requires extreme discipline.
While there are many popular versions of trend investing, many of the criticisms involve day-trading, or similar short term trading. I believe these strategies are poorly thought out; the taxes and trading costs are likely to eat you alive even if your "paper performance" is good. But that doesn't mean you should throw out the baby with the bathwater and ignore all versions of trend investing.
In macro-style trend investing positions are bought and held for months, if not years. Generally new contributions and dividends are used to buy into existing positions rather than looking for a new signal on a new product. Trend investing is just a set of rules which tell when an asset is acceptable, and when it must be sold.
Converting Academic Research Into An Investment Strategy
The strategy that I developed is unique. But that doesn't mean it's purely my own creation. The strategy is based off of work and research done by Antonacci, Jegadeesh, Titman, Faber, Fama, and other academics or industry professionals.
The difficult part of momentum and trend research is converting that basis of knowledge into actionable strategies which should provide pervasive and reliable returns. That's where the development of my own investment approach comes into play.
The challenging part is using these academic principles without having the powerful back-testing tools available to large institutions. Also, many of the products I use have only been around for 10 years at most. In a broader sense, Antonacci in particular has done a great job of demonstrating the power of momentum going back to 1974.
In truth, I don't believe there is a perfect investment strategy that exists. Back-testing, while important, can always be tweaked and prodded to find anomalies. However, using the principles, I believe there exists a potential for great performance.
My 10 Rules: Macro-style Trend Investing
- Invest in lower cost broad country, region, or asset class index ETFs as appropriate, stocks can be used if they are representative of the asset class and the index ETF is not liquid enough for the desired position size;
- Except for U.S. Large Cap or EAFE, no new position can be more than 20% or less than 10% of the portfolio;
- New purchases must be trading above a predefined SMA or EMA, long averages for taxable accounts, somewhat shorter is acceptable for TFSA/RRSP accounts;
- Avoid new purchases of broad indices with extremely high Shiller-CAPE ratios (>30), even when they're in an uptrend;
- Each position must be sold when it trades below the predefined SMA or EMA;
- Use stop-loss orders where you can to avoid doubting sell signals;
- Each position should be held until sell signal, except when partially sold to accommodate a new eligible position;
- Hold no more than six positions in the total portfolio to keep costs down and the portfolio easy to manage;
- Consider using leverage with a wide safety margin, if available at a low cost;
- When no eligible positions exist, hold short-term government bonds or cash.
What the Portfolio Looks Like
The end result of this strategy is you would generally hold somewhere between two and six broad positions in the portfolio. In Canada, when trading in Canadian dollars, the options are a little more limited than they are in the U.S. where Blackrock iShares offers a wide range of country ETFs at a moderate cost.
While draw-downs will occur, their overall effect on the portfolio will be limited due to the sell signals. Using the combination of Simple Moving Average and Exponential Moving Average means you will almost always repurchase positions at a lower price than the selling price. This limits some of the negative effects of whip-saw often seen in trend investing.
Some positions are just more prone to volatility, such as commodities or emerging countries. Although not critical, it would be wiser to hold these positions in registered accounts if possible.
It's impossible to perfectly time the markets, but using the Rules it's possible to sell before getting hit with long bear markets and buy only months after the markets turned around. In my view that's a pretty reasonable compromise.
The effectiveness of the general buy and sell signalling mixed with short term bonds are fantastic. Take for example one of the longest running, low-cost ETFs in Canada: XIC.TO.
For simplicity's sake, your split-adjusted returns (excluding dividends) for buy and hold would have seen growth from $13/unit on February 16, 2001 to $24.15/unit today. The annualized compound growth was 3.95%.
Over the same time period, using my rules and a 200 day SMA/EMA, an investment in XIC.TO would have seen a compound annual return of 13.7% (excluding dividends). In both scenarios, dividends and distributions would have added around 2.5%.
Although over the time frame there were a number of "wasted" trades and during a few periods the buy-and-hold approach would have been somewhat better, the Rule method would have seen substantially lower draw-downs which translate into great returns.